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Margin Trading in Forex

Margin trading allows the Forex trader to deposit a small amount of money to control a much larger actual amount in the market. It simply means that if your retail Forex broker allows leverage of 100:1 it means that for every $1000 in the trading account the trader can purchase $10,000 worth of currencies, which is like using $1000 as surety to loan $10000 from your bank. (100,000 /100=1000) This in turn means the trade size is also magnified 100 times allowing very small fluctuations in the value of the currency to create large changes in the value of your account. The down side is that a losing trade is also magnified 100 times and reckless use of margin and leverage can quickly wipe out the trading account. Retail brokers became more creative and decided to split the $100,000 into smaller lots of $10,000 to create a mini account, and some even split the $10,000 into $1000 trades called micro accounts, making it far easier for smaller investors to start trading without risking huge amounts of money. Assume therefore the retail broker allows 100:1 leverage on a $10,000 mini account the trader can trade $10,000 worth of currency for every $100 in his trading account. The approximate value of the smallest incremental move in the market (1 pip) will be equal to $1 risk or reward for the trader. So if the market moves 10 pips (or .10 of a cent) in a positive direction the trader will have made 10$ in a market that can regularly move 100 pips in a single day. $10 is equal to 10% of margin or 1% of capital gain for a very small move in the market. The opposite is obviously true that if the move was negative then the trader would have lost the same amount of money. Hypothetically the trader could have traded 10 lots with only $1000 in the trading account and the same 10 pip move would have generated a profit of $100 equal to 100% of margin or 10% of capital; and vice versa a negative move would have lost the trader 10% of his capital. Whilst the use of leverage and margin is vital for small traders to be able to participate in the largest market in the world, abuse of leverage or high risk trading will soon lead to the demise of the trader by wiping his account out very quickly. Whilst there are plenty of Retail Forex brokers out there who will encourage the use of more margin appealing to the greed in human nature to try and achieve unrealistic results. The trader should not be lured into this trap as the broker earns his income directly from the trader. The larger the trade size the more the broker earns. To summarize margin and leverage allow traders with small amounts of capital (traders can open a trading account with as little as $250) to participate in the market. Leverage is a two edged sword that can allow a trader to make large profits from very small moves in the market but also lose large amounts from those same small moves. Note: Forex traders should do their homework and open trading accounts suitable to the amount of capital they have available to trade. Don’t be fooled into opening an account where the minimum pip size is too large for the amount of capital in the trading account. Take time to educate yourself on the dangers of margin trading, or start with the minimum amount of capital acceptable to your broker in order to open a trading account and get your feet wet with a small live account whilst learning the ropes.